Bidding Wars: What Escalation Clauses Mean For VA Borrowers

Across the country, real estate markets are booming. According to the National Association of Realtors existing home prices in April were up 11 percent when compared with a year ago.

Rising home prices are good news in most households. Many borrowers who were once underwater now have equity simply because home prices have risen overall. Not only that, in some cases, those who want to sell can now find a welcoming marketplace, one which includes multiple home offers.

But what about those in the market to buy? Should purchasers who will use VA financing be in the hunt when a single property attracts multiple offers?

VA purchased home

Many borrowers who were once underwater now have equity simply because home prices have generally risen.

Multiple Home Offers Mean Escalation

VA loans can surely be used to finance home purchases, including situations where a home receives multiple offers. In practice such sales often work like this:

Imagine that both Smith and Jones really like a house. They instruct their broker to bid $200,000. But they also have escalation clauses in their offers, clauses which say the broker is authorized to raise their bid automatically by $1,000, or $2,000 or whatever number is appropriate.

In this situation, when Smith sees a $200,000 offer, he immediately goes to $201,000. In response, the Jones bid is automatically increased to $202,000. Then, seeing what Jones bid, the Smith offer instantly rises to $203,000.

Such financial ping-pong raises an important issue: While the bids can rise automatically with escalation clauses has either buyer limited the top dollar he or she is willing to offer? If not, when does the bidding stop?

Multiple Bids, Multiple Issues

Here are several thoughts about multiple bids.

  • First, VA mortgage borrowers should have financing lined up before bidding. Know how much VA financing is available to you and what’s affordable in terms of allowable monthly payments for principal, interest, taxes and insurance.
  • Second, avoid a bidding war based on ego and status, trying to outdo someone else. Bids should have a firm economic basis, so buyers do not overpay.
  • Third, buyers should feel free to make multiple bids, but be careful with escalation clauses that automatically increase your bid after someone else submits an offer. Make sure the number of escalations is limited, and that the final dollar size of your bid does not exceed a specified point.

Focus On The Price

When there are multiple bids, the focus is on the prices being offered. That’s realistic, however, since real estate bids involve both price and terms. Sometimes the winning bid is not the highest offer, but instead is an offer which sets a closing date the owners prefer or has fewer contingencies.

For specifics regarding multiple bids speak with local real estate brokers. Ask if such situations are common in your area and how they are handled when they arise. Also ask about the use of escalator clauses and the protections you want to prevent runaway bids.

Photo courtesy Anne Rossley